How investing is like driving your car
Here are some habits of highly successful investors
When I drive my car, I don’t know how the internal mechanics work. I know if I push on the accelerator, the car speeds up. If I hit the break, the car slows down and stops. If I turn the wheel one way or the other, the car will turn in that direction.
Investing is very much the same. A typical investor does not need to know the beta. Sharpe ratio or alpha of an investment. They just need to know the basics of investing to grow wealth. During my career as a Wealth Management Advisor, I have met with thousands of investors. I have observed clients that have made mistakes based on emotional decisions and I have met with clients that have made lucky decisions. However, I noticed a trend with the habits and decisions made by many people with wealth.
Build and Maintain an Emergency Fund
The foundation of every financial plan starts with an emergency fund of 3 to 6 months of living expenses. An emergency may include events such as job loss, disability, or appliance failure. I like to call this “life”. When “life” happens, an emergency fund allows you to cover those costs without using a credit card or accessing other long-term investments. An emergency fund is the foundation of an individual’s wealth. A savings account or money market account is a great place to grow and maintain an emergency fund.
Keep Fund Expenses Low
Investing in no-load funds with low internal expense ratios will lead to higher accumulations than a similar funds with higher charges. The math is very simple. The less money you pay, the more money you will end up with. Being aware of hidden mutual fund charges is the first step and then finding companies with low fees is the second step. Many companies such as TIAA-CREF and Vanguard offer no-load mutual funds with low internal expenses.
Systematically Save in a Tax Efficient Manner
Rome wasn’t built in a day and unless you win the lottery or your rich Uncle Jed leaves his oil money to you, your wealth will take years to build. In a society that wants instant gratification, saving a small amount on a monthly basis can be frustrating. Many of my wealthy clients have been saving monthly into a retirement plan, Roth IRA, and mutual funds for 30 years or more.
In addition to taking a disciplined approach to systematically investing, making sure you are using the correct vehicle according to your goals is extremely important. Vehicles such as 401(k)s, 403(b)s, SEP IRAs, Roth IRAs, Traditional IRAs, and 529 College Savings Plans are examples of investment vehicles that can be used to save systematically but also provide tax benefits.
A diversified portfolio means investing strategically in multiple asset classes that are going to react differently in various economic conditions. Many clients I have with wealth found an appropriate allocation based on their risk tolerance and time horizon to their goals. A diversified portfolio can help investors smooth out some of the volatility associated with the markets.
Money causes emotion and makes investors act in irrational ways. I have seen investors move money out of stocks at the bottom of a bear market to turn around and place it back in the stock market after a 50 percent run up. The stock market is going to be volatile and it is important that investors realize that they should not panic. Decisions to move money out of stocks based on emotion may lead to bad decisions and opportunities lost when the stock market recovers.
While many of the habits referenced above may be more complex than I have covered in this article, these basic concepts provide a framework for most investors. Following these basic habits will provide a guideline to become a successful investor. It is also the responsibility of the investor to educate themselves to understand these basics concepts.
Many investors feel overwhelmed by the prospect of researching financial information. However, there are many resources available to help you navigate through the research process. These resources include a mentor that has recently retired, magazines, websites, mutual fund company phone centers, and financial advisors.
Just remember: investing is like driving a car.